Economics

Monetary policy

A motivational speech

I JUST returned from the Brookings Institution, where one of the newest members of the Federal Reserve Board of Governers, Harvard economist Jeremy Stein, delivered his first speech as an FOMC member. You should read it; Mr Stein is a very good economist and he gave a very nice talk on the nature of the benefits and costs of large-scale asset purchases and on how those applied to the Fed's latest purchase programme: a plan of ongoing purchases of mortgage-backed securities at a rate of $40 billion per month.

The talk was most interesting, from my perspective anyway, for the light it shed on the Fed's evolving thinking (though usual caveats apply: Mr Stein's views were his own and not necessarily representative of the FOMC as a whole). Early on, Mr Stein noted:

If the federal funds rate were at, say, 3 percent, we would have, in my view, an open-and-shut case for reducing it.

I suspect the issue has been long-since resolved in the minds of many observers, but it is increasingly clear that there is a discontinuity in the Fed's reaction function when rates fall to zero. Now in my view, that fact ought to seriously change the way we think about long-run Fed policy goals, including the appropriate inflation target. It also leaves open the possibility that we ought seriously to rethink the case for countercyclical fiscal policy. It may suggest that in a world of very low inflation and very low inflation expectations, the odds of ZLB events are higher than widely understood, such that fiscal multipliers might well be higher than often estimated (as the IMF is coming to appreciate).

BUT, we need to append an important proviso: the case for fiscal interventions will depend on precisely which of the costs of unconventional policy is motivating the Fed to change its policy reactions. The more worried the Fed is about inflation and "de-anchored inflation expectations" the more likely it is that fiscal stimulus will simply push up the date of policy tightening, reducing the multiplier. If the worry is something else, however, like adverse financial-market impacts, then there is every reason to think that fiscal stimulus would work and could work very well.

There are different risks to different sorts of unconventional policies, however. Mr Stein also noted:

While much of my discussion will focus on the direct hydraulic effects of LSAPs on the economy, it should be emphasized that their overall impact may be augmented via a signaling or confidence channel. Another important tool in the Committee's arsenal these days is its use of forward guidance about the expected path of the federal funds rate. And a change in this guidance was a key part of the September FOMC statement, with the Committee stating that "a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens." I believe that the LSAP component of the statement helped bolster the credibility of the forward guidance component by pairing a declaration about future intentions with an immediate and concrete set of actions. And I suspect that this complementarity helps explain the strong positive reaction of the stock market to the release of the statement.

When you rely more heavily on expectations management to provide a boost, you don't run into the financial-market problems you get with large Treasury purchases, like a shortage of safe or money-like assets. And so in Q&A after the speech, former Fed Vice-Chairman Donald Kohn asked the obvious question: why not rely more heavily on the expectations channel?

Mr Stein answered that the Fed was working to do this, and that its language on forward guidance was a part of that. He also noted that he didn't think pegging rate rises to a calendar date was particularly helpful, since the message such statements communcate about the Fed's desired outcome depends hugely on what future conditions are forecast to be. The calendar dates "muddled the objective", he said.

But he also argued that the change in the language in the September statement was a real step forward. In particular, the statement that the Fed would allow rates to stay low "for a considerable time after the recovery strengthens" helped provide a sense of under which conditions the Fed would raise rates, and correspondingly what conditions the Fed is piloting the economy toward. That turn of phrase is of a piece with Chairman Ben Bernanke's statement that the Fed will not immediately react to inflation above target under circumstances in which unemployment is still high. That conversation, Mr Stein added, naturally leads to a debate about targets and thresholds, which he intimated has not been resolved within the FOMC.

But the most telling exchange of all came when Mr Kohn asked Mr Stein for his view on the debate Michael Woodford reignited in an August speech: whether a different target might be more suitable at the present moment, but more broadly whether the Fed should be trying to raise inflation to spark recovery.

Mr Stein's response was seemingly categorical: He "understood the logic" of the models which indicated that a higher inflation rate at the ZLB would reduce real interest rates, sparking a faster recovery. But he stated firmly: "that's not right". He has several questions about the assumptions leading one to such a conclusion, not the least of which was whether people would see through higher nominal interest rates to the lower real rates, should inflation quickly lead nominal rates to go up.

A fairly categorical response, seemingly. But I asked him what, practically, was the difference in a policy in which the Fed actively sought higher real growth while also expressing a tolerance for inflation temporarily above target and a policy in which the Fed explicitly sought higher inflation. And the key difference, he seemed to say, was in the motivation for the two policies. In particular, he argued, we've learned that being at the ZLB is dangerous and challenging for policymakers, and so a lag in the reaction to higher inflation is appropriate in order to avoid immediately falling back to the ZLB after finally leaving it. The Fed might want to give the economy a cushion against the ZLB, in other words.

As best I can tell, however, that's a distinction without a difference. Leaving the ZLB will require a rise in nominal interest rates, either because markets are observing higher inflation and adjusting nominal rates accordingly or because the Fed is observing higher inflation and adjusting its policy rates accordingly. If the Fed's motivation is to reestablish a cushion against the ZLB, then it is effectively expressing a desire for the economy to run hot for a little while, long enough to get inflation up and influencing nominal rates. Now perhaps the motivation is not to achieve higher inflation in order to lower the real interest rate and speed up the recovery. But I don't think that matters. The message markets, firms, and households ought to hear and understand—if in fact this view is gaining adherents within the FOMC—is that the Fed wants a faster recovery in order to achieve higher inflation and it is prepared to keep buying assets until it gets it.

That's basically the same thing. And a change in policy. And good news for the economy, as far as I'm concerned.

“the Fed wants a faster recovery in order to achieve higher inflation and it is prepared to keep buying assets until it gets it.”

So the Fed wants to create the same artificial expansion today that it created from 2001 – 2007. We can expect similar results, for it would be irrational to expect different results from the same action.

If the Fed's only existing mandate were to control inflation, you would have a good point. But the Fed actually has a two-fold mandate, doesn't it? It is supposed to both control inflation and control unemployment. Rather frequently, when things are not going smoothly in the economy, a tradeoff is required.

It appears, if I am reading you correctly, that you thing the trade-off should be to always and only worry about inflation. Which may be a valid policy preference, but would require that the Congress actually revise the law to give the Fed a new direction. If they don't, then perhaps you should be directing your ire at Capitol Hill.

Yeah, Im convinced now - there's no hope with this crew, and won't be any until meetings like the one RA attended are attacked with drone strikes. As usual, RA saves the worst for last -

"The message ... is that the Fed wants a faster recovery in order to achieve higher inflation and it is prepared to keep buying assets until it gets it."

IMO this policy is outside the scope of the Fed's existing mandate, and implimenting the program without expressed approval from Congress is unlawful - the 'T-word' is appropriate here, but it would be a distraction to use it. It is not an idle distraction to wonder if violence is now appropriate in response to this apparent Wall Street 'putsch'.

Violence isn't appropriate, but you can easily make money off it. For example, Bloomberg had an article yesterday about a hedge fund manager who made billions selling selling MBS's to the Fed.

Smaller players like us need to be in assets that benefit from the Fed's craziness. Buy stock in the worst part of a recession (not now, but coming to a theater new you soon). Farm land has increased 30%/yr in Nebraska.

So the distinction is the nature of the signal about the future that the Fed is trying to send. And the question is whether that future signal is meaningful. Good or bad. OK.

Or it may be the institution is acting within the constraints of its precedent, being ever mindful of the scope of its signals. So this is what they can say. So the distinction is the effect of the past shaping what they intend to be a signal about the future and they have more faith in that because it fits what they are and what they have said in the past. OK.

As to the second, I'm not sure motivation matters.

As to the first, the questions are blunt: will this get us off the zero bound? Will it force money off the sidelines into use? If it does, then we can ask if the nature of the signal mattered or if it was the reality of the action that counted. If it doesn't, then we can ask if the nature of the signal hampered, if we would have been better off saying "we're going to inflate". And we may not be able to figure out the answers to those questions.

The relative ease with which monetary stimulus can be extended in the downturn (and therefore increase the balance sheet by bond buying), the same ability is halted to unwind the stimulus (and therefore sell the assets) when the upturn starts and this asymmetry in the transmission mechanism translates into shocks that impact the price-wage stickiness.

The same is true as given in the IMF report on page 67, when it comes to government deficits, where it is easier to operate with deficits in the downturn while difficult to reduce the same when the upturn starts.

These asymmetries do not bode well with the general perception that monetary and fiscal actions can be made effective if the timing is right and is in measured dozes.

“Just before leaving public office in 2001, Gore reported assets of less than $2 million; today, his wealth is estimated at $100 million.”

Of course, he learned from the master. Keynes invested in gold stocks while advising governments to devalue. Gore invested in “green” energy while advising governments to waste billions on it:

“Fourteen green-tech firms in which Gore invested received or directly benefited from more than $2.5 billion in loans, grants and tax breaks, part of President Obama’s historic push to seed a U.S. renewable-energy industry with public money.”

Yes, I can protect myself - in theory anyway - by passing off the inflation-vulnerable parts of my portfolio to others, but not everyone can or will. No matter how you slice it - somebody has to hold those assets and that risk all the time.

More to the point, why the hell should anyone have to sit still for this kind of sneak-attack on his finances? These financial vandals have no legal or moral standing to justify their actions. Killing them is as morally neutral as killing vipers in your back yard IMO.

No, the Fed and those who own it have seized control of the institutions of government and have commenced to employ them for their own personal enrichment, and at the expense of the financial standing of those not of their ilk.

I don't think it can be asserted in good faith that the Fed has any mandate to target savers for expropriation of assets, or anyone else either, for that matter. Yet they do so.

IMO the proper response to this illegal usurpation of the authority of government is the killing of the usurpers, not a repositioning of assets in a futile attempt to become one of them. IMO acquiesce is not a moral obligation in this circumstance. As the institutions of government have been corrupted, it falls to individual citizens, acting on their own initiatives, to take the measures forced upon them by the wrongdoers.